The world’s largest independent power and water project (IWPP) reached its financial close on June 21. Unusually, it was not the Gulf’s project finance hotspot, Qatar, that sewed up the deal, but Saudi Arabia, when a syndicate of 29 banks extended limited recourse lending worth $3.44bn to the Marafiq IWPP in Jubail on the east coast. The market believes many more such deals will follow in the conservative kingdom.
Growing needs
According to Emmanuel Rogy, head of Europe, Middle East and Africa energy project finance at lead arranger BNP Paribas (BNPP), while a steady but smaller flow of deals will keep banks interested in Bahrain, Oman and the UAE, “the Saudi Arabian market has been growing and is continuing to grow, due to the kingdom’s huge needs”.
He points to a forthcoming financing for the $9bn Saudi Kayan Petrochemical Company, for which a consortium of BNPP, Arab Banking Corporation and Samba Financial Group is acting as adviser to Saudi Basic Industries Corporation. “This will look for in excess of $5bn, and will set a size benchmark.”
Other deals in the pipeline for the second half of 2007 include two multibillion-dollar financings being sought by Saudi Arabian Mining Company for separate phosphate and aluminium projects.
Led by BNPP, Gulf International Bank and Samba, the IWPP financing secured by a sponsor group led by Suez Energy International fell into five tranches: a 22-year, $1.57bn bank loan; a $645m export credit facility guaranteed by the Korea Export Insurance Corporation; a $600m Islamic ijara (leasing) facility; an equity bridge facility of $496m; and a debt service reserve account facility of $130m.
“As the largest-ever IWPP, we thought the syndication process might need some robust efforts – but it was heavily oversubscribed. The three underwriting banks were planning a general syndication, but the first-tier participation was such a success that this was unnecessary, Mr Rogy tells The Banker.
“The words liquidity and strong appetite best describe the current Middle East market – the classic sign of this is the trend over the past 24 months of oversubscriptions at the sub-underwriting stage for almost every deal,” he says.
Saudi focus
Other leading players agree that Saudi Arabia is the main focus. Darren Davis, HSBC’s regional head of project finance, says: “In terms of project finance demand, the strongest market is easily Saudi Arabia.”
The attraction for financiers goes beyond government sector projects, Mr Davis says, citing how a group of mainly regional banks recently provided an eight-year, $575m refinancing for the Saudi Polyolefins project, sponsored by Tasnee and Basell, with pricing at just 65 basis points (bp) over Libor – a level that would have been a challenge for government projects to achieve as recently as 18 months ago. “Generally, Saudi Arabia is characterised by relatively few but very large project financings, with $5bn projects almost becoming the standard now. As shown by the recent Marafiq deal and Saudi Ethylene and Polyethylene Company deal last year, borrowers are having to look beyond the bank market, bringing in export credit agencies as a key part of the financing structure.” Next year “the capital markets are likely to play an important role for the first time”.
Transactions where $3bn or more is required are generally the trigger point for a more diversified funding approach, says Mr Rogy. “To maintain the competition among banks, we have to bring in other liquidity, and keep the commercial tranche at anywhere between $1bn and $1.5bn,” he adds.
Impressive volume
An eye-catching feature of the market has been the volume of Islamic financing tranches being injected alongside conventional lending, especially in the larger Saudi projects. Saudi International Petrochemical Company recently tapped SR2bn ($533m) worth of ijara facilities from five regional banks to support its new project developments, including the Jubail Acetyls Complex. And law firm DLA Piper has predicted that about $30bn worth of sukuks (Sharia-compliant bonds) will be issued by the end of this year, although they are not being used in project finance structures.
“Sukuks have not been used directly in project finance yet, given the shorter tenors available, but they have been used to finance projects indirectly – that is, the underlying asset being financed isn’t repaying the sukuk,” says Mr Davis. “But we think that sukuks will be used more as ever more sources of liquidity are needed.”
Shariah-compliant products that are being developed in the Middle East will have a big impact on the global project financing market, according to some observers. “The world’s biggest financial institutions are moving towards Islamic financing,” says Hassain Hamid Hassan, one of the region’s leading Shariah advisers.
Dr Hassan argues that conventional project finance providers will be attracted to Islamic financing because “banks can go ahead with self-mitigated risk”.
Depending on the Islamic financing structure, banks may keep the project title and then lease the asset to the customer, who will own the asset at the end of the financing period. “This is equity-based financing… [the asset] is owned by the financier for some time,” says Dr Hassan, who is president of the fatwa and Shariah supervision board at Dubai Islamic Bank and holds other posts at entities that deliver, develop or monitor Shariah-compliant financial products.
Financial institutions taking a stake in the underlying asset have to be more diligent in assessing the feasibility of a project before agreeing to finance it, says Dr Hassan, who argues that there are safety nets in this form of financing. “If it goes wrong, the bank could terminate the project, sell it in the market or sell it to a third party,” he says.
However, Sattam al-Zamil, group finance manager at Zamil Group Holding Co in Saudi Arabia, disagrees with Dr Hassan’s view that banks worldwide see the benefits of Islamic financing. “They’re doing it because customers are asking for it,” he suggests, although he hopes that more financial institutions will see the benefits of Shariah-compliant products in time.
The group began using Islamic finance in the mid-1990s and since then it has only employed Shariah-compliant products, says Mr al-Zamil. But Islamic products still need to be refined, he says, calling for more standardisation among banks, more consistency among the Shariah scholars who decide whether a financial product is halal (allowed) or harem (forbidden), and a clearer regulatory environment. But he says that he is prepared to tolerate such market imperfections. “We will never go back.”
The next test of financiers’ appetite could be seen in Oman, where a $1.4bn transaction was due to be launched last month for Oman Refinery Company. “This has a hybrid, semi-corporate project structure, so will push the market’s capacity and appetite,” says Mr Davis. “On the other hand, liquidity remains high for quality borrowers in the region, with new banks setting up in the region on an almost weekly basis, or at least joining deals in the region.”
Water project
All the signs looked good for Oman when the sultanate’s first independent water project (IWP) secured a 22-year, $170m project loan, for which documentation was signed in mid-May. This marked the “longest deal to date in Oman”, says a banker close to the deal, which has been underwritten by Société Générale and Royal Bank of Scotland. He emphasises that the transaction involves banks taking risk on “a de facto private company”, the Mazoon Electricity Company, one of 10 new businesses set up after the May 2005 unbundling of Oman’s power and water sectors.
Momentum in privatising Oman’s power and water sectors will continue with the Salalah 2 IWPP in south Oman, where financing is “expected to close by end-year”, says Sohail Barkatali, a partner at law firm Berwin Leighton Paisner.
Looking further ahead, Mr Rogy forecasts that “a new wave of infrastructure projects over the next 18 months” will evolve the market, whose deal flow has thus far gravitated mainly around power and IWPP projects as well as the series of large-scale Qatari gas and petrochemical schemes that have tapped tens of billions of dollars from the markets. Again, Saudi Arabia will lead the way, via huge schemes such as the proposed Saudi Landbridge railway project that is envisaged to link the kingdom’s two coasts.
Different drivers
“So much infrastructure is needed across the region, but the commercial drivers are different,” cautions Mr Rogy. “Infrastructure financing relies on the users to pay for the facilities, or on the host government to guarantee a minimum revenue, so additional state involvement and legislation will be necessary. Everybody has less experience, so there is a challenging time ahead for all involved.”
The major spoiler in the story is the rise in construction expenses. “The economics of the projects are getting stretched, because capital costs have continued to rise significantly and, importantly for the gas projects, feedstock is no longer as cheap or abundant as 10 years ago either,” says Mr Davis.
However, the price of much project output has concurrently improved “and where economies of scale can be achieved, this will justify the increased capital costs at the outset,” argues Mr Rogy. “That’s why the project sizes have increased and why small-scale projects are sometimes put on hold.”
He concludes: “It won’t be this way for ever – one day the cycle will turn down.”
